We are a contractor working under an NEC3 Engineering and Construction Contract (ECC). When submitting compensation event quotations, we have always included allowances for any risk in our forecast of defined cost. We try to ensure that such allowances are a genuine estimate of the defined cost of risks that have a significant chance of occurring due to the effect of the compensation event. But in assessing compensation events, the project manager often reduces our risk allowance or removes them entirely. We consider this to be unreasonable.
Do you have any guidance on how the contract intends for such risk matters to be allowed for within compensation event assessments? We intend to try to persuade the project manager that how we are pricing the risk allowances is reasonable and should be allowed for in their assessments.
You can only allow for risks which have a ‘significant chance of occurring’, see clause 63.6. That means it is not a case of allowing for ‘any risk’, no matter how remote. There will be some compensation events where there will be no risks that have a ‘significant chance of occurring’, so always adding something is not correct. You need to identify the risk and explain why you think it has a significant chance. When doing so there can only be an ‘allowance’ for that risk, which must be based upon the percentage chance of it occurring. You cannot allow for the whole cost and time, because it may not happen. That is the essence of a risk allowance. Equally, there will be cases where there is a risk involved, especially when there are a lot of unknowns. Therefore, the project manager cannot just automatically reject all risks for all compensation events.
The same considerations need to be made as when tendering for work. If you can demonstrate making allowance for such risks in your original tender, that will be a factor for you and the project manager to consider. The ECC guidance notes give some further help on this and suggest a possible method to take the heat out of any dispute.
We are afraid that a judgement as to what has a ‘significant chance of occurring’ and what should be allowed for it will be heavily fact-dependent. It is also linked with what allowances you have made when forecasting the resources and times for the activities involved. That forecast may well include the ‘normal’ risks for doing the works, especially if it is based upon known outputs actually achieved.
Finally, if your assessment is based upon the actual defined cost of the work already done (see the wording in clause 63.1), there can be no need to add for any risk. This is because it has either happened and has been allowed for, or has not happened and does not need to be allowed for.